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In Japan, a Tenuous Vow to Cut

TOKYO — As Japan’s fiscally conservative finance minister, Yoshihiko Noda long sounded the alarm on the nation’s ballooning government debt. It is more than twice the size of its $5 trillion economy — and rated more risky than that of Italy and Spain.

Now, after Mr. Noda was elected Japan’s prime minister this week in response to the nation’s natural and nuclear disasters, the question is whether he can administer his prescription: raise taxes while reining in spending.

“We will no longer spend wastefully as if we are pouring buckets of water into a sieve,” Mr. Noda declared in a speech on Monday just before Japan’s ruling Democratic Party elevated him to the top job.

But that political resolve could prove hard to sustain — and not simply because of the systemic weaknesses that have resulted in six prime ministers in the last five years.

This is a country that was already addicted to its public spending, even before the huge needs of the postquake reconstruction. The last time the Japanese government ran a budget surplus was in 1992, almost two decades ago. Tax income now covers less than half of Japan’s annual budget.

Mr. Noda’s call for fiscal restraint is timely, given the global context. Last month, the ratings agency Standard & Poor’s stripped the United States of its top credit ranking, saying political paralysis in Washington was making the country less creditworthy. In Europe, bond investors make daily sport of handicapping the relative risks of the debt loads shouldered by members of the euro monetary union.

“Sovereign risk is spreading to, and starting to engulf, large economies that were previously unaffected,” Hideo Kumao, chief economist at the Dai-ichi Life Research Institute, said in a recent research note.

For years, Japan has managed its gargantuan debt load, and bond buyers have been willing to lend the government money at some of the world’s lowest interest rates. But for various reasons — including that low tax rate and Japan’s aging, shrinking population — the borrowing binge is looking unsustainable.

On July 23, Moody’s Investors Service lowered Japan’s credit rating by one notch, to a level two grades below the top rating, saying weak prospects for economic growth, as well as its recent disasters, made it difficult for the government to tackle its debt.

In the near term, though, Mr. Noda’s government has little choice but to spend on postquake reconstruction. The government estimates that losses could reach as much as 20 trillion yen ($260 billion) just for the natural disasters, excluding costs from the continuing nuclear crisis at Fukushima.

That means spending on a scale unprecedented even for Japan, whose decades of public works projects are a big reason that the national debt is expected to reach 228 percent of its gross domestic product this year. That is far higher than even debt-saddled Italy, at 118 percent, and the United States, at 92 percent, according to the International Monetary Fund.

And in trying to raise taxes, Mr. Noda must contend with a painful historical precedent: an increase in the consumption tax meant to help finance rebuilding after the 1995 earthquake in Kobe snuffed out a nascent economic recovery. The consumption tax has not been raised since.

A particular headache for Mr. Noda is a party heavyweight who has turned rebel: Ichiro Ozawa, a longtime advocate of robust government spending to prop up growth, and a fierce opponent of raising taxes.

Mr. Ozawa backed the second-place candidate in the party ballot, and to appease him Mr. Noda is expected to tone down the fiscal hawkishness and hand out cabinet posts to some of Mr. Ozawa’s allies. The new cabinet may be named as soon as Friday in Tokyo.

“We expect that, unless economic uncertainty is wiped out completely, a tax rate increase will be quite difficult next year to finance reconstruction projects,” said Masaaki Kanno, an economist for JPMorgan Securities.

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Why does Japan’s debt burden matter? After all, despite Japan’s highest debt-to-gross-domestic- product ratio, and less-than-stellar debt ratings — a couple rungs below even the downgraded United States — Japanese bond yields remain the lowest among advanced economies. This signals that bond buyers, far from seeing Japan on the fiscal brink, regard the Japanese government as exceptionally creditworthy.

“Japan is not Greece, or even the United States,” Akira Kojima, a senior fellow at a Tokyo-based private policy research organization, the Japan Center for Economic Research, said in a research note. “Japan can finance its deficit on its own.”

Mr. Kojima referred to the current-account surplus Japan has run for most of the last three decades, selling and investing more overseas than the other way round. And Japan’s notably thrifty households sit on 1,500 trillion yen ($20 trillion) in savings. The Japanese government is in deep debt, but the rest of Japan has ample money to spare.

And Japanese investors have long been happy to buy up government bonds. In contrast to Greece and other afflicted economies in the euro zone that are heavily indebted to foreign creditors, 60 percent of Japan’s government bonds are held by Japanese banks, insurance companies and pension funds. An additional 20 percent or so is owned by governmental organizations and the Bank of Japan.

Throw in individual investors, and 95 percent of Japan’s debt is held domestically. That makes the country less vulnerable to outside pressures that might cause it to default. And in theory, it gives the government plenty of leeway to print money — a spendthrift’s prerogative it holds in common with the United States.

“Unlike the peripheral euro zone countries, where bond yields can easily spike without official support, Japan still boasts the luxury of being able to issue debt in a market full of willing buyers,” said Cameron Umetsu, Tokyo-based economist at UBS Securities. “This is one luxury the government should exploit while it can.”

While it can. That is the crucial caveat.

After the collapse of its boom of the 1970s and ’80s, Japan has since the 1990s poured yen after yen into stimulus programs trying to revive the economy, while letting tax revenue atrophy.

And now, demographics are taking a toll. Social security and pension costs have soared as Japan’s baby boomers reach retirement, while the birth rate is so slow that the population is actually shrinking.

Not only are there going to be fewer taxpayers, but Japan’s savings rate is falling, as more pensioners start dipping into their nest eggs, shrinking the pool of money available for government bond purchases.

And it is unclear, analysts say, how much longer Japanese banks and pension funds will keep up their appetite for government bonds that bring in little interest.

The Bank of Japan could buy up more government bonds to make up for a slack in demand, but within the bank there is strong opposition to such moves, which many fear could fuel inflation.

All of which is why analysts see little chance of any bold fiscal moves from Mr. Noda’s new government. “It’s as if the crisis that faces Japan’s finances has been completely forgotten,” Masataka Nakajima, a special researcher at the Japan Securities Research Institute wrote in a recent report.

Mr. Noda, as evident from his “sieve” speech, hasn’t forgotten. But he had a big distraction right now: putting together yet another emergency budget for Japan’s crippled economy.

A version of this news analysis appears in print on September 2, 2011, on Page B1 of the New York edition with the headline: In Japan, A Tenuous Vow to Cut. Order Reprints|Today's Paper|Subscribe